Australian interest rates need to be higher, and before long will be forced up, perhaps considerably. Today’s meeting of the board may find reasons to delay, but a massive surge of mining investment, a Federal budget still in substantial deficit and an outbreak of wage inflation will force the Reserve’s hand before long.
The Reserve Bank will be blamed for robust defence of its inflation target, and when the non-mining parts of the economy are in recession RBA governor Glenn Stevens will again be described as Australia’s most useless man. The real reason is the renewed China boom impacting on an economy with rigid labor laws, restricted skilled immigration arrangements and a government that utterly fails to understand how the economy works.
Delay today is probable because of renewed concern about the state of the American and Eurozone economies. The clearest global indicator is the savage equity sell-off in all major markets. In the case of the USA, continued large falls in housing prices are driving many more Americans into seeing negative equity in their greatest asset, the family home. Loss of confidence in continued recovery by US business has produced a far weaker than expected increase in jobs in the private sector. When one’s employer is nervous and one’s family deeply concerned at its financial well-being, it is hard to consume at the excessive rates that have been normal in western nations.
The Eurozone is in superficially better shape, but it is wise to remember that the rate of unemployment is close to 20 % in the weaker Eurozone nations. Adherence to the Euro for these nations is like being crucified on a cross of gold, but with a far less impressive scaffold. If the weaker Eurozone nations had the ability to devalue their currencies, necessary fiscal retrenchment would be less costly. Instead, pursuit of the impossible dream of becoming as efficient and productive as the German heartland will do nothing but condemn these nations to a long depressed future. Surely soon the Eurozone adherence to a single currency shall end and be discarded as a step too far in economic integration.
Other concerns about global growth are less pressing but cannot be overlooked. China is fighting inflation imported from America, and rightly feels let down by the global superpower that insisted on providing the global currency after the second great war of the twentieth century. Will China allow its currency to revalue faster and find a way to slow its economy enough to stem inflation without putting the economy into a severe slowdown that will for a time check and indeed reduce commodity prices globally? Such an outcome would also create massive civilian unrest in China, as indeed would continued inflation. Like the RBA, the People’s Bank of China will be blamed if it gets the balance wrong. Its highly difficult task is to engineer what one wag called the ‘Two Pandas’ solution, the Chinese version of the story of the three bears.
Australia’s economic data can only be examined with a sense of deep foreboding. The renewed mining boom is already building steam, boosted by rebuilding from the floods of the first quarter. Australia’s terms of trade continue to set new records and, unlike previous episodes of global commodity inflation, this episode is likely to run for years or even decades. Massive investment in infrastructure, new mines and expansion of output from existing mines is already underway and coming up against a shortage of skilled labor sufficient to produce very large wage hikes. The brutal fact is that to achieve the necessary switch of resources to the mining sector requires fast reduction of resources from sectors such as manufacturing, tourism, education and other largely non-mining activities. The high Australian dollar is already impacting on these sectors and further interest rate hikes, taking monetary policy from neutral to tight, will impact both directly and through its effects in driving the Australian dollar higher.
I am strongly opposed to reacting to a single economic statistic, a task done far more efficiently by Australia’s journalists. But the strong rise in retail sales in April, if it was not just a statistical artefact, may be signalling a return to traditional consumerism. If a renewed consumption boom were to be added to the current economic stew it would be severely damaging. As we know, goods and services inflation is already ‘surprising on the upside’ while the number of unreported large wage claims even Henry has been told about would make any serious central banker’s hair curl.
It is now too late to prevent severe strains on Australia’s two speed economy. Actions that could have made the adjustment less painful would have included keeping the ‘structural’ budget in surplus, establishing a sovereign wealth fund to build offshore investments as the actual budget moved into surplus, tackling far sooner the perverse incentives that encourage people to accept welfare rather than seeking paid employment and maintaining, perhaps further reforming, policies to encourage employment. This is not to suggest that firing a university professor in the hope that he (or she) will find a job driving trucks in the Pilbara would be especially helpful. Immediate relaxation of regulations limiting the temporary import of skilled labor is one policy that could just about be managed if the government understood the pressures that are building now.
Above all, the government should include in its economic ‘narrative’ both the vast opportunities and the substantial risks now faced by Australia. By responding quickly and positively to the renewed mining boom we can properly embed ourselves in the massive boom that China, India and other smaller developing economies are creating by embracing economic development so vigorously. The geopolitical benefits will be substantial, as we will be seen to have positively aided the development of our near neighbours. Australians shall become far wealthier. But there will be costs, costs of painful adjustment in particular, costs that cannot be avoided, if we are to succeed.
The RBA will be forced to act, but real debate remains to be had. Bring it on, Mr. Abbott, and no-one but the Labor leaders can say you are carping and negative.
Published today by The Australian. (Beware typos)